Tuesday, August 9, 2016

Money series: is the money that you put in a bank still yours?

First of all a question: do you think that if you deposit, say, 1000 € at your local bank, or in an online bank, that money is still yours?

Well, sorry to disappoint you, but the money that you put in your bank account is not yours any longer: in fact, it belongs to the bank. Legally.
The bank can decided whatever it wants to do with that money.
The bank has only a liability towards you, in that it is obliged by the law to give you the money back if you ask for it.
We have already talked about what liabilities and assets are on a very general basis in a previous post: that post was meant to let you conceptualize what an asset is and what a liability is. Assets and liabilities are accounting jargon, but if you understand their inner meaning, you will be far better off than most of your friends, colleagues and relatives.

When you deposit 1000 € in your bank, the bank takes legal ownership of the money, and it simply record in a ledger that it owns you 1000 €.

Why is it a liability? well, a liability is something that sucks the money away. In this case, the bank is supposed to pay you an annual interest on the money deposited. So, for example, if the bank grants you 1% of interest on the money you deposited, it means that after one year the money in your bank account has become 1000 € + 1%, that is 1010 €.

So, the money you deposited is a liability for the bank because the bank has to pay you an interest over the sum that you have deposited.

NOTE: today this is no longer the case with many banks. They do not even give you an interest on the money you deposited.
Why does the bank pay you an interest? if it is like that, it seems unprofitable for a bank to give extra money "for free".

The interest the bank pays you is the main reason why you do not keep cash under the mattress. The cash does not bring any interest.

NOTE: this is theoretical. We will see in the future that to keep cash may be better than keeping it in the bank account under particular conditions.

The bank pays you an interest because:

1. the bank takes your money and, even if it pays you 1% of interest, it may well invest your money in more profitable projects. So, to do that, it has to pull you in with a yield that is more than zero.
2. the bank carries on a risk, in that it may not refund your money if it goes bankrupt. This is not known and understood by the people, but when you lend your money to somebody (in this case a bank) there is ALWAYS the risk that you do not see your money back again, no matter what they can say.

So, we have cleared up that when you put your money in a bank, that money is not yours any longer; it belongs to the bank. The bank grants you the right to withdraw that money sometime in the future, for example by an ATM, or by going to the clerk at the desk and ask for the money back.

Ok, we understand that if we put 1000 € in a bank, that money belongs to the bank: but who created the 1000 €?

Before answering to this question, which is very complex to give an answer to, let's clear up a point:
when you deposit 1000 €, you mean banknotes, cheques or a bank transfer?

Of course it may be both. You can step into a bank and deposit 1000 € cash, get a receipt and check your online bank account. The same if you deposit a cheque.
If you make a money transfer from one bank (say bank A) to another (bank B) , the procedure is the same.
The only difference, which is invisible to you, is that in this case there is not even a transfer of a physical quantity (banknotes or the paper of the cheque) from you to the bank, but a simple transfer of information from bank A to bank B, in the forms of 1's ans 0's.
So, money is currently only a set of long strings of ones and zeroes that get transferred from one bank account to another.
Do you know how 1000 € looks like in digital format, as stored in a bank's registry? They look like this: 0000001111101000.

So, when you deposit a cheque, or cash, or make a bank transfer from your bank to another, the account in the receiving bank account is increased by 0000001111101000, that is 1000 €.

So, an interesting point: do you think that in case of hyperinflation we will see images like this, where you can see on the left a gentleman sweeping away with a broom valueless banknotes during the German crisis in the '20s?

No, we won't. Because now money is digital.

This is just to show you that, whoever creates money today, he does that by typing numbers on the keyboard of a laptop.